FOMC Raises Rates By 25 BPS As Expected, But Now Sees 3 Hikes Instead of 2 in 2017

As was expected, the Federal Reserve’s (Fed) policymaking arm, the Federal Open Market Committee (FOMC), decided to raise rates by 0.25% (25 basis points) at the conclusion of its two-day meeting. The move had been fully priced into financial markets for the past month or so. This is the second rate hike in this cycle. The first was a year ago in December 2015. Here is a side by side comparison of the statement released today versus the statement released at the last FOMC meeting on November 2, 2016. The big story in today’s meeting is that the FOMC now expects to raise rates three times next year; at the September 2016 FOMC meeting, the Fed expected just two hikes in 2017, and the market and the Fed were aligned on that assessment before today.

In its statement, the FOMC made few changes to its assessment of the labor market, the overall economy, household spending, and business capital spending relative to November, but meaningfully upgraded its view of the labor market. For the second straight meeting, the FOMC sounded a bit more concerned about inflation, noting that “Inflation has increased since earlier this year.” In addition, the FOMC said that “Market-based measures of inflation compensation have moved up considerably.” As it did in November, the FOMC highlighted that the “near-term risks to the economy are roughly balanced,” and the statement again mentioned the committee would “monitor inflation indicators and global economic and financial developments,” a phrase that has been in every FOMC statement this year.

As it has for a year, the FOMC noted that it expects the pace of rate hikes to be gradual and that any future hikes are data dependent and not on a preset course.

The Fed also released a new set of economic forecasts and dot plots at today’s meeting, as it does four times a year. The key takeaways here are that FOMC members now think the Fed will hike rates three times in 2017, down from two hikes embedded in the September 2016 dot plots. The FOMC still expects three 25 basis point hikes in 2018 and 2019, as it did in September. The long run fed funds rate—what the Fed would consider neutral—rose from 2.875% in the September 2016 dot plots to 3.125% today. This is the first time in nearly five years that the Fed has moved up its assessment of the long-run fed funds rate. Fed Chair Janet Yellen was conducting her fourth and final press conference of the year as this blog was being prepared.

As of now, Fed speakers are not scheduled between now and year-end. The minutes of today’s FOMC meeting will be released on Wednesday, January 4, 2017, and the Beige Book for the next (January 31-February 1, 2017) FOMC meeting is due out on Wednesday, January 18, 2017. President-elect Donald Trump’s State of the Union Address in late January/early February will be of keen interest to the Fed and Fed watchers. In addition, the mid-February 2017 appearance by Yellen before Congress for her semiannual monetary policy testimony will provide the market with insight into the Fed’s views on any specifics on fiscal policy provided by the incoming Trump Administration and Congress in early 2017. The interaction between fiscal and monetary policy in 2017 is a key concern for markets.

IMPORTANT DISCLOSURES: The economic forecasts set forth in the presentation may not develop as predicted. The opinions voiced in this material are for general information only and are not intended to provide or be construed as providing specific investment advice or recommendations for any individual security. Basis Points are a unit relating to interest rates that is equal to 1/100th of a percentage point. It is frequently but not exclusively used to express differences in interest rates of less than 1%. The Beige Book is a commonly used name for the Fed report called the Summary of Commentary on Current Economic Conditions by Federal Reserve District. It is published just before the FOMC meeting on interest rates and is used to inform the members on changes in the economy since the last meeting. Monetary policy is the process through which the monetary authority (central bank, currency board, or other regulatory committee) of a country controls the size and rate of growth of the money supply, which in turn affects interest rates. The Federal Open Market Committee (FOMC) is the branch of the Federal Reserve Board that determines the direction of monetary policy. The eleven-person FOMC is composed of the seven-member board of governors, and the five Federal Reserve Bank presidents. The president of the Federal Reserve Bank of New York serves continuously, while the presidents of the other regional Federal Reserve Banks rotate their service in one-year terms. This research material has been prepared by LPL Financial LLC.

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